Fed votes to further raise rates

Bank loans benchmark goes up 0.25% to 3.75%

September 21, 2005|By Bill Sing

The Federal Reserve chose inflation-fighting over public relations yesterday, raising its benchmark short-term interest rate by another quarter-point to 3.75 percent against suggestions that it pause in deference to Hurricane Katrina.

The 9-1 vote to raise the federal funds target rate by another quarter percentage point to puts the key interest rate at its highest level since August 2001.

In response to the Fed's action, commercial banks began raising their prime lending rates by a corresponding amount, to 6.75 percent. These rates are used for many short-term consumer loans, including some credit cards and popular home equity lines of credit.

The central bank's policymaking committee also signaled that further rate increases were in store, adding that although Katrina and accompanying energy price volatility "have increased uncertainty about near-term economic performance ... they do not pose a more persistent threat."

With little long-term economic damage expected from Katrina, the committee reiterated its mantra that it could continue to boost rates at a "measured" pace - Fed-speak for more quarter-point increases.

The decision wasn't unanimous. Fed Governor Mark W. Olson voted against the rate increase, preferring that the central bank stand pat. It was the first formal dissent among Fed policymakers since the central bank began its current rate-boosting program in June 2004.

The Fed's 11th consecutive quarter-point rise in its federal funds rate to a four-year high was one of the most widely debated central bank decisions in recent years, given the sudden and broad economic shocks from Katrina. Some analysts had suggested that the Fed should pause in a show of compassion for Katrina victims and a recognition of the economic uncertainty created by the storm.

Instead, "the Fed has not been deflected from its prior course by Hurricane Katrina," said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, N.Y.

Higher rates are likely on a variety of consumer and business loans, including variable-rate credit cards and home equity loans. However, savings rates also will probably rise.

Stock market investors, who had hoped that the central bank might signal a relaxation in its rate-raising agenda, were disappointed by yesterday's news.

After trading in positive territory before the Fed announcement, major stock indexes closed lower, with homebuilders and retailers among those taking the biggest hits. Bond yields were mixed.

The rate increase didn't damp a debate among analysts about whether higher inflation is a serious threat, and whether the economy is strong enough to regain momentum after Katrina.

Some analysts said Fed Chairman Alan Greenspan and his colleagues should have paused, arguing that the economy is in danger of a slowdown amid surging energy costs, a decelerating housing boom and rising interest rates.

Katrina may have wiped out 400,000 jobs. Consumer confidence plunged after the hurricane, raising the specter of a pullback in consumer spending.

"All the facts aren't in" on Katrina's effect, said James D. Hamilton, an economics professor at the University of California, San Diego. Given that uncertainty, "it makes a lot of sense to wait a couple months and see what it's all going to bring."

Other analysts, however, note that inflation threats are mounting. Hurricane Rita threatens energy production facilities in the Gulf Coast, heightening prospects for more increases in fuel prices.

Various transportation companies, including airlines and truckers, are trying to pass along higher fuel costs. Contractors warn of rising costs for building materials.

"Given these telltale signs of inflation, the [Fed policymaking committee] has judged that the risk of standing pat is greater than hiking the rate another notch," said Sung Won Sohn, an economist and chief executive of Hanmi Bank in Los Angeles.